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Hedge fund directors warned on insurance

Date: Wednesday, August 3, 2011
Author: Charles Gubert, COO Connect

Hedge fund directors need to be more aware about the threats they face from investor claims.

Directors should utilise specialist insurance brokers who are able to negotiate broad policy coverage if they are to effectively protect themselves against investor claims.

“Fund directors can sometimes face complex claims and they cannot rely on ‘off the shelf’ insurance coverage. They need to go to individuals who understand the market they are operating in so to ensure a valid claim is paid,” said Shyam Moorjani, managing partner at insurance broker Baronsmead Partners.

A Directors & Officers’ (D&O) policy is designed to successfully transfer their personal liability by paying defence costs as well as damages. This is important as some claims can even go against the director’s personal assets. Areas where directors can incur liability from claims include misrepresentation in the prospectus, asset mis-valuation, poor oversight of service providers and treatment of redemptions.

“Directors can also sometimes find themselves exposed to costly claims if 'exclusions' are not addressed on their policies. These 'exclusions' can be incredibly broad and directors should carefully study their insurance agreements to understand what they are but also how they are written”, warned Moorjani.

“Exclusions can include fraud, claims arising from US investors, claims arising from when a fund goes into insolvency, claims from major shareholder (holding more than 15%) and those arising from a fund holding ERISA money. When thinking about exclusions, the director needs to think about them in their broadest possible interpretation as this is how the insurers are likely to apply them,” he added.

Directors are also likely to have broader exclusions in their policy if they are covered under a composite policy - whereby the funds and manager are covered under a single policy. This, again, can void a pay-out by restricting cover for claims against the manager by the funds because it may exclude claims from one insured party versus another.

“If there is no directors’ insurance - or the insurance does not pay - then the directors will look to the fund for an indemnity. In this case, the indemnity payments will come straight out of investors’ assets, probably at a time when there has already been a significant drawdown in the fund. Directors do not want to find that, without the correct insurance, they become just one of many unsecured creditors in the event of a fund’s insolvency,” he said.

“A lot of directors see insurance as a necessary evil but having a decent policy in place is essential. Cheapest is often not the best solution and a director must engage in the quality of cover otherwise they are likely to get a poor outcome, “stressed Moorjani.